Companies that decide to defer their IPO plans in light of current market conditions would be wise to spend some time on efforts to improve the diversity of their boards. This WilmerHale memo (p. 13) addresses SEC & Nasdaq rules, proxy advisor & institutional investor policies, state law requirements and other drivers of increased board diversity that need to be considered in the IPO planning process. Here’s an excerpt on the growing number of state law initiatives addressing board diversity:
States are playing an increasingly active role in promoting board diversity among companies that are incorporated under their laws or satisfy other criteria. For example, California and Washington mandate specified levels and types of board diversity, while Illinois, Maryland and New York mandate disclosure regarding board diversity. Other states are considering mandatory board diversity legislation, or have adopted (or are considering) non-binding resolutions urging public companies to increase board diversity. This is a quickly evolving area; companies need to monitor developments in applicable states to remain in compliance.
The memo also points out Goldman Sachs’ decision not to underwrite deals for companies that don’t satisfy board diversity standards. While it says that other bulge-bracket banks haven’t as yet followed suit, it also emphasizes that the momentum created by various other stakeholders’ efforts to promote diversity is something that needs to be taken into account by IPO candidates.
According to this Audit Analytics report reviewing 21 years of “going concern” qualifications in public company audit reports, 2020 was a bit of a milestone year. Here’s an excerpt from the report’s intro:
The number of companies that received a going concern opinion during fiscal year (FY) 2020 declined to a record low of just 1,261. The percentage of companies that received a going concern opinion during FY2020 also declined to a record low of 17.9%. Going concern opinions have been declining since they peaked during FY2008 with 2,851 – during the height of the financial crisis. FY2008 also saw a high of 28.2% of companies receive a going concern opinion.
The gradual decline in going concern opinions since FY2008 had brought the percentage of companies that received a going concern opinion in line with pre-financial crisis figures. But the steepness of the FY2020 decline has brought all new lows. The decline was led by improvements from smaller and mid-size companies. Non-accelerated filers saw a 10.5 percentage point decline, and accelerated filers saw a 5.5 percentage point decline in the percentage of companies that received a going concern opinion during FY2020.
The report also addressed the reasons for going concern qualifications. Many reports listed multiple factors, but leading the pack was “recurring losses,” which was cited in 71% of all 2020 going concern opinions. While that’s down from its peak of 85% in 2018, the recurring losses issue was still cited twice as much as cash constraints, which were the second most frequently cited issue. The report notes that despite the SPAC boom, the percentage of reports citing no or limited operations as a reason for a going concern qualification declined over the past decade from 48% to 21%.
Over on “Radical Compliance”, Matt Kelly blogged about a recent Association of Fraud Examiners benchmarking report on the technologies companies use to fight fraud. The blog says that corporate approaches to detecting and preventing fraud could use some updating:
The most telling line in the report comes right at the start: “Our study indicates that the most commonly used analytics are the tried-and-true techniques that organizations have found success with for decades,” such as exception reporting and anomaly detection, as well as automated monitoring of red flags and business rules. More than half of respondents said they use such techniques.
Along similar lines, the two risk areas most commonly monitored with analytics were fraudulent disbursements and outgoing payments (cited by 43 percent of respondents) and procurement and purchasing fraud (41 percent of respondents). That’s great, but outgoing payments and procurement are financial functions that every business in the universe has, and two primary vectors for fraud. So it’s only natural that they’re also the functions most likely to get the anti-fraud analytics treatment.
On the other hand, if we want an example of companies not yet embracing the full potential of anti-fraud analytics, the ACFE also had an interesting stat about what sources of data companies use for their analytics efforts. Eighty percent of respondents said they use structured data, such as invoice amounts listed in databases or dates included on purchase numbers. Only 33 percent, however, used unstructured data — random information that might exist in emails, PowerPoint presentations, or other sources, and that doesn’t neatly export into an Excel table.
Unstructured information is where the good stuff is, especially for frauds that involve multiple employees who might be talking with each other about their scams. That said, unstructured information is also more difficult to process. “This highlights that most organizations still rely heavily on traditional analytics approaches and data sources to drive their anti-fraud programs,” the ACFE says. Indeed.
The blog explores other areas covered by the report, including the surprising number of companies that don’t use case management software and the increasing importance of technology in fraud assessments in the Covid-19 era.
Law firm lawyers wouldn’t dream of practicing law without having a malpractice policy in place, but those policies are far from ubiquitous among in-house lawyers. This Woodruff Sawyer blog takes a look at whether in-house lawyers should consider malpractice insurance. The blog says that the good news is that if you’re worried about your employer suing you, that’s unlikely. (Of course, getting fired is a whole other kettle of fish). However, this excerpt says that there still may be some situations in which “employed lawyers insurance” may make sense:
So, when is employed lawyers insurance useful? Here are a few scenarios:
Someone Other Than the Employer Perceives an Attorney-Client Relationship with You. Say, for example, during your day-to-day dealings with other employees, someone casually asks a question about whether he should exercise his options, or about a speeding ticket or an apartment eviction. If this person now perceives that you are his lawyer because of that exchange, it’s possible that he could sue you for malpractice.
Employed lawyers insurance gives an extra layer of protection here, but it’s certainly better to avoid casually giving advice to folks who are not your clients. Your best practice is to be deliberate about refraining from giving legal advice to those with whom you do not want to have an attorney-client relationship.
If you’re in a work environment where, as a cultural matter, you feel obligated to answer these types of questions, employed lawyers insurance is something you might consider. The same is true if part of your job is to give advice to third parties that are not technically the same as your employer, for example the charitable trust “arm” of your employer.
You Are Moonlighting. Employers sometimes encourage their employees to moonlight on a pro bono basis. Employed lawyers insurance responds if you are sued for malpractice as a result of these activities. The insurance will also typically provide your defense costs should you find yourself the subject of a hearing in front of the California Bar.
You Are Concerned That Your Employer Won’t Indemnify You. You may work for an employer whom you perceive will not defend you if a third party (a vendor or customer, for example) decides to sue you for legal malpractice for whatever reason, or you are worried that your company might be insolvent (and thus can’t indemnify you) at the time of the suit.
The blog reviews how these policies work and their typical exclusions, and also addresses alternatives, including personal indemnification agreements and, in some cases, D&O insurance.
This recent article by Bloomberg Law’s Preston Brewer analyzes the results of a survey of in-house & outside securities and capital markets lawyers concerning allocation of drafting responsibilities. The survey suggests that in-house and outside counsel are usually on the same page when it comes to who should take the lead role in drafting documents, but this excerpt says that there are also some interesting areas of divergence:
Law firm attorneys overwhelmingly see due diligence request lists (68%) and term sheets (68%) as duties within their purview, while 62% of in-house respondents said they would keep due diligence lists in-house—and a full 75% of them view preparation of term sheets as a task for in-house counsel.
Less dramatically, substantially more outside counsel said they would assign themselves securities offering documents (a margin of 15 percentage points for SEC Form S-1 registration statements and private placement memoranda). For closing checklists, an astounding 100% of law firm attorney respondents would give the work to themselves versus 82% of in-house counsel choosing to assign that work to outside attorneys.
I don’t know about you folks, but speaking for myself, if an in-house colleague offered to take drafting responsibility for due diligence requests & term sheets for deals that we were working on, they would immediately move into the LARGE holiday gift basket category.
The survey found that 41% of respondents said they expect more work to go to outside counsel over the next five years, while 20% expected more work to go to inside counsel & 39% expected the mix to remain the same. That number surprises me, given the high & ever-increasing level of expertise among corporate law departments – although it may be a bit skewed by the fact that 28 of the 47 survey respondents were law firm lawyers.
The survey has a bunch of other interesting material in it involving both private and public companies, and one of the biggest takeaways is that both outside and in-house securities lawyers are pretty optimistic about the future of their practice. Attorneys feel strongly that corporate practice and securities law is a growth industry for both law firms and in-house counsel. The survey says that 70% expect increased activity in private company work, and more than half expect growth in private equity and public company representations.
Okay, a few years ago, I blogged about research suggesting that the much-maligned staggered board was actually good for shareholders. That renaissance lasted about two days, at which point it became painfully obvious that investors were having none of it. Now, I’m again peeking out of my shell to highlight another study that says staggered boards may be beneficial. Here’s the abstract:
Staggered boards (SBs) are one of the most potent common entrenchment devices, and their value effects are considerably debated. We study SBs’ effects on firm value, managerial behavior, and investor composition using a quasi-experimental setting: a 1990 law that imposed an SB on all Massachusetts-incorporated firms. The law led to an increase in Tobin’s Q, investment in CAPEX and R&D, patents, higher-quality patented innovations, and resulted in higher profitability. These effects are concentrated in innovating firms, especially those facing greater Wall Street scrutiny. An increase in institutional and dedicated investors also accompanied the imposition of SBs, facilitating a longer-term orientation. The evidence suggests SBs can benefit early-life-cycle firms facing high information asymmetries by allowing their managers to focus on long-term investments and innovations.
No, I’m not exactly sure what “Tobin’s Q” is either. You know who does know though? Cooley’s Cydney Posner, who has taken a deep dive into the study and its conclusions over on her blog. To me, the big takeaway from all of this is that while we’re all in favor of good corporate governance, the evidence continues to suggest that nobody really knows exactly what that is.
The folks at Bass Berry recently held a webcast on the new universal proxy rules and have posted this blog summarizing the key takeaways from the program. Among other things, the blog includes a chart that briefly comparing the differences between the typical proxy access bylaw and the universal proxy rules. As you know, I can’t resist quick reference materials that I can quickly glance at and use to fake my way through a conference call, and this chart clearly makes the cut. Check it out!
Targets of SEC enforcement proceedings and advocacy groups have long complained about “regulation by enforcement.” Crypto evangelists have been particularly vocal with regulation by enforcement claims in recent years, but it looks like at least one of them may have effectively figured out how to use regulation by enforcement to its advantage, Check out Matt Levine’s take on the SEC’s recent enforcement action against BlockFi:
If a crypto startup went to the U.S. Securities and Exchange Commission and said “we want regulatory clarity about what we need to do to run crypto lending programs, so you should write some rules about it,” the SEC would say “sure, we’ll give that some thought in like 2036.” If it went to 50 different U.S. states and asked them for clarity it would get even more confused. If it went to the SEC and said “look, to speed this process along, why don’t we pay you $50 million to prioritize writing these rules,” that would be a very bad crime and it would go to prison. But BlockFi will give the SEC $50 million, and it will give some states another $50 million, and now it has clarity about crypto lending programs.
That’s a classic example of being handed a lemon and turning it into a very expensive glass of lemonade, and it’s also a unique twist on the problem of “regulation by enforcement.” BlockFi had the resources to use regulation by enforcement to its advantage, but that’s not typically the case.
Now, here’s where I should note that the current director of the SEC’s Division of Enforcement says that regulation by enforcement is a problem that doesn’t exist. That’s a view that he shares with many of his predecessors, but it’s one that’s not always shared by SEC commissioners or the courts. Here’s an excerpt from the 2nd Circuit’s 1996 opinion in SEC v. Upton:
Due process requires that “laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited.” Grayned v. City of Rockford, 408 U.S. 104, 108 (1972). Although the Commission’s construction of its own regulations is entitled to “substantial deference,” Lyng v. Payne, 476 U.S. 926, 939 (1986), we cannot defer to the Commission’s interpretation of its rules if doing so would penalize an individual who has not received fair notice of a regulatory violation. See United States v. Matthews, 787 F.2d 38, 49 (2d Cir.1986). This principle applies, albeit less forcefully, even if the rule in question carries only civil rather than criminal penalties.
In the current environment, it seems fair to say that regulation by enforcement concerns are by no means limited to issues surrounding digital assets. The SEC is under enormous pressure to move forward on its current regulatory agenda, and enforcement actions may be seen as an attractive shortcut in some areas. As I’ll explain with a couple of examples below, the risk of regulation by enforcement is heightened by the increasing influence on the SEC and other regulators of novel academic interpretations of what the securities laws require – interpretations that run counter to longstanding and well-known business practices.
– John Jenkins
Programming note: our blogs will be off Monday for Presidents’ Day, returning on Tuesday.
In recent months, long-time SPAC structures that were spelled out in hundreds of registration statements reviewed by the Staff of Corp Fin have been called into question, most notably in a lawsuit filed by former SEC commissioner & NYU Law School professor Robert Jackson & Yale Law School professor John Morley. That lawsuit challenges Pershing Tontine’s compliance with the Investment Company Act, and calls into question underlying assumptions about the availability of an exemption from that statute that have been relied upon by SPACs for years.
That’s private litigation, not an enforcement proceeding – but its allegations concerning non-compliance with the Investment Company Act have been commented on favorably by current and former senior SEC officials. What’s more, in a recent article, one of those former officials, Harvard Law School professor John Coates, states that the SEC’s past inaction in the face of widespread belief in the availability of the exemption should not be an impediment to future enforcement proceedings:
Does the claim, then, reduce to a claim that a regulatory agency with a limited budget should be held to legally have given up authority if it does not bring an enforcement action when it could, even when the issue has been part of what even its promoters say was until 2020 a “backwater” of the capital markets?
No, I don’t think so. I think the claim reduces to a claim that an enforcement proceeding alleging that the typical SPAC structure violated the Investment Company Act would raise due process issues that could be avoided if the SEC opted to address these newly articulated concerns through rulemaking. I hope that’s the path that the agency will choose to take.
In addition to the SEC, the DOJ may find itself under pressure to use novel academic arguments to support enforcement activities – even in criminal proceedings. As I blogged last year, the DOJ has recently launched a major investigation into the business practices of short sellers. According to a recent NYT DealBook article, the legality of activist short sellers’ longstanding use of “short reports” has been called into question by Joshua Mitts, a professor at Columbia Law School:
Short sellers have long been told by their lawyers that as long as their reports contain no material inaccuracies and are not based on inside information, they have done nothing illegal. In the disclosure accompanying their reports, activist short sellers typically say they are short the stock but may cover at any time. And they add that they are not offering investment advice.
John Courtade, a former senior S.E.C. enforcement litigator who now represents short sellers, has designed some of these disclosures. “Scalping has to involve deception of some sort,” he said. “Just the fact that you’re going to close your position has never been held to be deception. If you look at the cases, they involve situations like not disclosing that you have a position at all.” But Mr. Mitts argues that whether the boilerplate disclosure is sufficient “has not been tested by the courts.”
The article says that the SEC is unlikely to move on a rulemaking petition submitted by Prof. Mitts, but that “it’s an open question as to whether the Justice Department will try to set a precedent by prosecuting short sellers for market manipulation under the scalping theory — or any other one not yet tested.”
I’m not a fan of SPACs or short sellers, but I am a fan of due process – and I think that there’s a legitimate risk that the SEC and the DOJ may cross the line in the upcoming months if they bring enforcement actions or criminal proceedings premised on conduct that has long been engaged in openly, with the advice of experienced counsel, and under the noses of regulators.
